Unit 2

Management of Conversion System

Chapter 5: Capacity Design
Lesson 14:- Capacity management

Learning Objectives

After reading this lesson you will be able to understand

Capacity and its various measures
Capacity utilization
Capacity enhancement
Theory of constraints

Good Morning students, today we are going to introduce the concept of what is
known as Capacity management. The lecture introduces you to the concept of capacity
management. It begins with the definition of capacity and goes on to answer questions on
the issues of capacity utilization and capacity enhancement. After deciding what products
or services should be offered and how they should be made, management must plan
the capacity of its processes. Finally it focuses on the theory of constraints.

In our previous classes we have learnt what products or services are to be offered and how they
should be made. For making these products or for providing such services, men and machines
would be required to be properly coordinated. . Hence management must plan the capacity of its
processes.

What is Capacity?
Capacity is the maximum rate of output for a process. The operations manager must
provide the capacity to meet current and future demand; otherwise, the organization will
miss opportunities for growth and profits.

Capacity plans are made at two distinct levels:

Long term capacity plan –
 ( it covers at least two years in future)
(e.g. investment in new facilities and equipments)
Short term capacity –
(it covers week-to-week operation)
(e.g. it focuses on workforce size, overtime budgets, inventories, etc)
Dear friends, please bear in mind that too much capacity can be as agonizing as too little.
Searching for the optimal balance can often be quite an elusive affair and is one of the
strategic decisions that the management must tackle successfully.
What are the questions that assume significance in this regard?
Well,
Questions to be considered –
The relevant questions in this regard are:
How much of cushion is needed to handle variable, uncertain demand?
Should we expand capacity before the demand is there or wait until demand is
more certain?

Measures of capacity –
There are two main methods of measuring capacity. These are expressed as:
Output measures (choice for high volume process)
Input measures (choice for low volume flexible processes)
Output measures
Output measures are best utilized when the firm provides a relatively small number of
standardized products and services, or when applied to individual process within the
overall firm. Nissan Motor Company states capacity at its Tennessee plant as 4,50,000
vehicles per year. That plant produces only one type of vehicle, making capacity easy to
measure. However, many organizations produce more than one product or service. For
example, a restaurant may be able to handle 50 sit-down or 100 take-out customers per
hour. It might also handle 25 sit-down and 50 take-out customers or many other
combinations of the two types of customers. As the amount of customization and variety
in the product mix becomes excessive, output-based capacity measures become less
useful.
Input measures
Input measures are useful for low-volume, flexible processes. For example in a
photocopy shop, capacity can be measured in machine hours or number of machines. Just
as product mix can complicate output capacity measures, so as demand can complicate
input measures. Demand, which is expressed as an output rate, must be converted to an
input measure. Only after making the conversion can a manager compare demand
requirements and capacity on an equivalent basis. For example, the manager of a copy
center must convert its annual demand for copies from different clients to the number of
machines required.

When we talk about capacity planning it requires knowledge of the current capacity of a
process and its utilization.
My next question to you would be:-

What is capacity utilization?

Capacity utilization is the degree to which equipment, space, or labour is currently being
used. It is expressed as a percent.
Mathematically, it can be expressed as under:
Average output rate
Utilization = × 100%
Maximum capacity

The unit of measurement for both Numerator and Denominator should be same.

Utilization indicates the need for adding extra capacity or eliminating unneeded capacity.
Two definitions of maximum capacity, i.e.:
Peak capacity and
Eeffective capacity
are quite useful.
Let us focus on these aspects.
Peak capacity
The maximum output that a process or facility can achieve under ideal conditions is
called peak capacity. It can be sustained only for a short time, few hours a day or few
days in a month. A process reaches it by using marginal methods of production, such as
excessive overtime, extra shifts, temporarily reduced maintenance activities, overshifts,
and subcontracting.

Effective capacity
The maximum output that a process or firm can economically sustain under normal
conditions is its effective capacity. In some organizations, effective capacity implies a
one-shift operation; in others, it implies a three-shift operation. For this reason, Census
Bureau surveys define capacity as the greatest level of output the firm can reasonably
sustain by using realistic employee work schedules and the equipment currently in place.

When operating close to peak capacity, a firm can make minimal profits or even lose
money despite high sales levels.

Let us now see how to calculate these measures of utilization through an example.
Example 5.1
If operated around the clock under ideal conditions, the fabrication department of an
engine manufacturer can make 100 engines per day. Management believes that a
maximum output rate of only 45 engines per day can be sustained economical over a long
period of time. Currently, the department is producing an average of 50 engines per day.
What is the utilization of the department relative to peak capacity? Effective capacity?

Solution.
The two utilization measures are

Average output rate 50

Utilization = = × 100% = 50%
peak Peak capacity 100
 Average output rate 50
Utilization = = × 100% = 111 %
effective Effective capacity 45

Note- Even though the fabrication department falls well short of the peak capacity, it is
well beyond the output rate judged to be the most economical. Capacity expansion
options could be evaluated.

To increase the maximum capacity the process need to be focused more. Most
processes involve multiple operations, and often their effective capacities are not
identical. A bottleneck is an operation that has the lowest effective capacity of any
operation in the process and thus limits the system’s output. Figure 5.1 shows a process
where operation 2 is a bottleneck, whereas Figure 5.2 shows the process when the
capacities are perfectly balanced, making every operation a bottleneck.

Inputs

Figure 5.1 Operation 2 a bottleneck

Figure 5.2 All operations are bottlenecks

A project or job process does not enjoy the simple line flows. Its operations may process
many different items, and the demand on any one operation could vary considerably from
one day to the next. Bottlenecks can still be identified by computing the average
utilization of each operation. In this situation, management prefers lower utilization rate,
which allow greater slack to absorb unexpected rise in demand.
The long-term capacity of bottleneck operation can be expanded in various ways.
Investments can be made in new equipments, The bottleneck’s capacity also can be
expanded by operating it more hour per week, such as going from a one-shift operation to
multiple shifts, or going from five workdays week to six or seven workdays per week.
Managers also might relieve the bottleneck by redesigning the process, either through
process reengineering or process improvement.
At this point, I would like to point out an important fact regarding the Theory of
constraints.

Theory of constraints (TOC) refers to an approach that focuses on bottlenecks of a

firm’s financial performance.
Long-term capacity expansions are not the only way to ease bottlenecks. Overtime,
temporary or part-time employees, or temporarily outsourcing during peak periods are
short – term options. Managers should also explore ways to increase the effective
capacity utilization at bottlenecks, without experiencing the higher costs and poor
customer service usually associated with maintaining output rates at peak capacity.
The key is to carefully monitor short-term schedules, keeping bottleneck
resources as busy as practical. They should also minimize the time spent unproductively
for setups. When a changeover is made at a bottleneck operation, the number of units or
customers processed before the next changeover should be large, compared to the number
processed at less critical operations. Maximum the number processed per setup means
that there will be fewer setups per year and thus less total time lost to set ups.
The TOC is an approach to management that focuses on whatever hinders
progress toward the goal of maximizing the flow of total value – added funds or sales less
sales discounts and variable costs. The impediments or bottlenecks might be overloaded
processes such as order entry, new product development, or a manufacturing operation.
The fundamental idea is to focus on the bottlenecks to increase their throughput, thereby
increasing the flow of total value – added funds.
Let us now learn to apply this concept using sequential steps.
Application of TOC involves the following steps
It’s basically a five step process.

1. Identify the system bottleneck

2. Exploit the bottleneck
3. Subordinate all other decision to step 2
4. Elevate the bottleneck
5. Do not let inertia set in

Factors that determine capacity

Ultimately, the output from a production facility or system is not determined
simply by the physical size of the facility, the sizes or types of machines, or
the number of employees working. Production capacity, especially effective
capacity, is affected by the design of the products and processes, the training
of employees, the management of quality, and many other factors. The most
important factors affecting production capacity are:
1. Process design. In multistage production processes the maximum rate
of output that can be achieved is governed by the slowest) lowest
capacity stage.
2. Product design. With exactly the same personnel and equipment, the
capacity for making a product that is well designed for production will
be greater than for a poorly designed one.
3. Product variety. The fewer types of products made by a production
unit and the more similar they are, the more specialized equipment
and jobs can be, and the less time lost on product changeovers and
machine set-ups.
4. Product quality. The way products are made, tested, and inspected
will affect the rate at which products of acceptable quality can be
produced.
 5. Production scheduling. Scheduling that keeps product flows well
balanced and synchronized and unproductive time minimized will
utilize machines and personnel better and result in greater effective
capacity.
6. Materials management. Shortages of materials can cause work
stoppages, while excess inventories can cause congestion and wasted
time searching for materials.
7. Maintenance. Equipment breakdowns and defects due to machine
wear are two majors sources of lost production.
8. Job design and personnel management. The amount of output a
production system actually produces is greatly determined by the
personnel operating the system. Inadequate training, poor job design,
overwork, and absenteeism all lead to lost production.

We will now look at practical examples of these in the following two POM in practice.

POM in practice 5.1 – The agony of too much – and too little – capacity*
Carnival Cruise Line has a fleet of cruise ships that ply the waters off Florida. The
capacity of these ships is huge. The Destiny is its largest, which displaces 1,00,000 tons
and can carry over 3,100 passengers. But Carnival has been sailing in choppy seas during
the last year, plagued by three onboard fires and technical problems. The most pressing
problem, however, is the glut of new ships being added throughout the industry. Carnival
alone is bringing in a cadre of 15 new amenity-filled ships, boosting its fleet to 61. With
other cruise lines also adding to their fleets, the number of available beds jumped by 12
percent in 2000. But historically, passenger volume has grown at only about 8 percent
annually. Carnival argues that with the baby boomers now approaching their peak cruise-
vacation years, the industry has lots of room to grow beyond the 6.5 million people who
will book a cruise this year. “What is important to us is that we are building over the next
five years $6.5 billion worth of new ships”, says COO Frank. “We are going to continue
to grow our business, and we are going to grow it profitably”. Not everyone is convinced.
Some experts worry about the overcapacity issue and Carnival’s decreasing return on
investment. During 2000, the company’s share prices plunged by more than 50 percent.
For now, Carnival is filling its berths by slashing prices. After years of rising prices in
this industry, the capacity glut is causing the steep discounts. For a seven-day cruise, the
cheapest fare has dropped from $599 to $549, and discounted tickets have gone as low as
$359. Carnival is also adding a variety of shorter and cheaper voyages as a way to expand
the market, because high utilization is a key to success when its resources are so capital-
intensive.

The aircraft industry experienced the opposite problem in the late 1980s – not enough
capacity. The world’s airlines reequipped their fleets to carry more passengers on existing
planes and vie to buy a record number of new commercial passenger jets. Orders received
by Boeing, Airbus, and McDonnell Douglas surged to more than 2,600 planes.
McDonnell Douglas alone had a backlog of some $18 billion in firm orders for its MD-80
and new MD-11 wide body – enough to keep its plant fully utilized for more than three
years. Despite the number of orders, Douglas’s commercial aircraft division announced a
startling loss; Airbus struggled to make money, and even mighty Boeing fought to
improve sub par margins. Capacity shortage caused many problems for McDonnell
Douglas: Its suppliers were unable to keep pace, its doubled workforce was
inexperienced and less productive, and considerable work had to be subcontracted to
other plants. The result was that costs skyrocketed and profits plummeted. In 1997,
Boeing acquired McDonnell Douglas.
*Adapted from Operations Management Strategy and Analysis ( L. J. Krajwesky and L.
P. Ritzman) Prentice Hall

POM in practice 5.2 – Two examples of capacity planning#

The first example of resource requirements planning is for the Easton, Pennsylvania,
plant of Pfizer, Inc., which is in Pfizer’s Minerals, Pigments, and Metal Division. This
plant has annual sales of approximately $15 million, producing iron oxides for pigment,
ferrite, magnetic, and other applications. The products are industrial raw materials used in
paints, plastics, food, cosmetics, magnetic inks, recording tapes, and other products. The
two primary uses are for coloring of for magnetic properties.
The plant employs approximately 250 people and runs 24 hours per day, 7 days
per week. The plant produces only 50 end items, 30 o which account for approximately
90 percent of the volume. The products are produced to stock, with typical inventory
levels of 8 weeks finished goods, 4 weeks work-in-process, and 5 weeks raw materials.
Total customer booked orders is typically 3 weeks. About 90 percent of the shipping
dates are specified by the customer, and the plant is expected to meet these dates at least
95 percent of the time.
The long-term planning of plant facilities is done on a divisional basis. A
timeshared computer model converts forecasted product demand over a 10-year horizon
into resultant capacity needs by type of production process. These needs are matched
against current plant capacities so that capacity additions and cash requirements can be
planned. The end result is a pro forma cash flow and profit-loss statement. Changes in the
timing of capital additions are tested iteratively, as are differing assumptions about the
marketplace. This analysis is performed annually, and the result is the long-range
capacity plan.
The second example of strategic resource planning is for Dow Corning
Corporation, a multinational chemical corporation headquartered in Midland, Michigan.
The company produces silicon materials for both industrial and commercial applications.
Silicones are a unique family of chemical compounds not found in the natural
state that exceed the performance of natural synthetic carbonbase polymers. These
compounds commonly take the form of fluids, rubber, or plastic resin. The industrial
market served by Dow Corning includes applications in manufacturing processes such as
silicone fluids, emulsions, rubbers, and so on. The commercial market served by Dow
Corning includes such products as Dow Corning Bathtub Caulk, Sight Savers yeglass
cleaners, heat shields for spacecraft, and surgical devices (for example, pacemakers,
finger joints for arthritis, and drain valves). In total, the domestic plants produce 4000
packaged end products (including the packaging alternatives), of which 640 represent 90
percent of the sales dollars.
Dow Corning prepares a long-range estimate of production equipment needs
covering a 5-year period. This plan is expressed in terms of similar product family
groupings called PTUs (process train units). These PTU groupings are not market based,
but rather are established by identifying a family of products that have a unique initial
raw material and a common set of processing equipment requirements. In the domestic
plants, there are 200 PTU groupings, which aggregate the 4000 product-packaged
combinations and 1400 end-product types. These estimates of equipment processing
capacities are based on projections of the PTU production rats for individual plants which
are prepared by the production planner.
The process involves extrapolating the resource requirements of a given plan
using planning ratios between PTUs and resources. The resource plan serves as the basis
for the preparation of the long-run capital budget at Dow Corning.
#
Adapted from Applied Production and Operations Management (J. R. Evans at al) West
Publishing Company.
With that, we have come to the end of today’s discussions. I hope it has been an
enriching and satisfying experience. See you around in the next lecture. Take care.
Bye.